By Sara Yates, Global Head of FX Strategy at J.P. Morgan Private Bank
Viewed from 30,000 feet, it looks as though little has changed in the FX market over the past month. EUR and USD largely traded within a one per cent range, despite the European Central Bank (ECB) taking the unprecedented step of adopting a negative deposit rate in June. Even with a pickup in noise around Middle East geo-politics, most emerging markets have failed to pull away from USD by more than one percent on the month. With range trading the order of the day, it is no surprise that currency volatilities continued to push towards historic lows.
Looking more closely however, trends are emerging. In our opinion, the most important is that currency performance is being increasingly driven by the country’s relative economic performance and monetary cycle. We think it is therefore no surprise that across the EM and G10 world, the best performing currencies included those with booming economies whose central banks are either already hiking (NZD) or where the market is becoming increasingly excited about the prospect of near term rate hikes (MYR, GBP). At the other end of the spectrum, deflation and waning economic momentum saw the Riksbank surprise the market with a 50bps policy rate cut in June and helped the SEK underperform most of its EM and G10 peers. We expect relative economic performance to continue to dominate G10 currency performance and potentially drive a bigger wedge between GBP and the EUR.
The one exception is the USD. Despite more evidence that the economy is rebounding strongly from its snow filled start to the year, Yellen’s dovish helmanship of the Fed has helped keep US yields anchored a very low levels. In our opinion, this is unlikely to change until the Fed’s tapering programme ends and the market focuses more firmly on when its hiking cycle will begin. In the meantime, we think the market will continue to seek opportunities to hold currencies for their yield – reinforcing the range trading environment that has prevailed for the past few months.
Range trading is unlikely to be sustainable in the long term, in our opinion. Over the next 12 months, the market is likely to increasingly focus on the hiking cycles in many developed markets, not just a steepening of the US yield curve. We believe this necessitates pickiness in currency investments. We continue to think that the best opportunities remain within Asian FX markets.
INR: Our belief that Modi would poll strongly in the May election and propel the currency towards 58 made this our highest conviction currency pick in Q2 2014. Modi victorious result saw USDINR trade down to around 58.4 and sets up the possible for widespread spread reform in India. We expect this to be beneficial for the currency in the longer term. However, with the RBI seemingly determined to keep the currency stable, we see limited upside for now. Stability also suggests limited downside for the currency, even in an environment of rising US yields. As such, we continue to forecast USDINR at 60 in 1 year and like holding the currency for its high carry (yield).
IDR: Concerns about the impact of the raw material export ban, the underwhelming result of Jokowi’s opposition party in this year’s parliamentary elections and the more recent rise in the oil price have keep us on the sidelines in terms of the IDR so far this year. Although none of these issues are resolved and further underperformance cannot be rule out, we believe now is an opportune time to start building a long IDR position. In our opinion, there is more similarity than difference between the two presidential candidates. We also think it is possible that the current administration will tackle the much maligned fuel subsidy over the summer. Once we get past the election concerns, the economy is robust and could support further rate hikes if needed to back stop the currency. If we add to this increased central bank reserves and a currency that has only been meaningfully lower against the USD during the Asian crisis, we find it hard to believe that further IDR underperformance will last. This is why we are advising clients to hold a small long IDR position and be ready to increase it should the summer’s volatility provide an even better opportunity.
MYR: The MYR has been one of our top picks all year due to its success in leveraging off the on-going recovery in developed markets and near term possibility for rate hikes. More recently its position as a net oil exporter has provided another leg of support, helping the USDMYR break below our forecast of 3.20. With rate hikes still to come, we think this rally can extend further and recommend that clients continue to hold their long positions.